You can invest in one of three major categories as a mutual fund investor. There are debt funds, hybrid funds, and equity funds, albeit each of these has a sizable number of subcategories. Risk, returns, sub-funds, and tax treatment are the main distinctions between these broad categories.
Since every investor has different needs, not all mutual funds suit everyone. Equity mutual funds, for instance, are appropriate for investors aware of market volatility and willing to take chances. Also available are small and mid-cap equity funds, which are suitable for investors with risk tolerance levels. Such investors should also have a minimum investment horizon of five years or more. They will be able to grow and combat market swings thanks to this.
Returns Scale
The magnitude of rewards and risk should typically be equal because returns are typically inversely correlated to the amount of risk you incur. One aspect, the Total Expense Ratio, has the potential to be significant (TER). The total expense ratio, or TER, is added to the fund NAV. The degree of TER often changes depending on how much active management is done. For instance, in the equities category, sectoral and diversified funds have high TERs in the vicinity of 2.5%. In contrast, index funds have much lower TERs due to the absence of active management.
Due to its passive nature, the arbitrage fund has a substantially lower expense ratio in the hybrid category than the balanced fund, which has a TER of over 2% higher. Closed-ended and liquid debt funds have lower expense ratios than average income funds regarding debt investments. Additionally, your NAV and thus your returns are affected by whether you choose a regular or direct plan. Concentrating on keeping TER as low as possible when it comes to returns is usually preferable to obtain greater alpha in challenging markets.
Taxation Scale
There are only two categories of taxation to calculate the taxation on dividends and capital gains. Dividends from equity funds, debt funds, and balanced funds are tax-free in the hands of the investors. Dividend distribution tax (DDT) is charged at a different rate. While dividends from equity funds are subject to a DDT of 10%, those from debt funds are subject to a substantially higher DDT of 25%. Let’s now concentrate on the taxation of capital gains in each of these scenarios.
The Income Tax Act recognises only two types of funds: equity funds and debt funds. For tax purposes, a fund is considered an equity fund as long as it has an equity exposure of more than 65 per cent. Therefore, equity funds will include sectoral funds, index funds, diversified equity funds, balanced funds with more than 65 per cent in stocks, and arbitrage funds.
Investment Horizon
Equity mutual funds, where the recommended investment period is at least 5 to 7 years, are available to investors with long-term financial goals. And to earn strong returns, investors with medium-term financial goals can put money into hybrid funds for at least three to five years (better than debt funds).
Bottom Line
It becomes dangerous to put the entire amount in one basket. Instead, mixing equity, debt, and hybrid mutual funds into a portfolio can help investors diversify their holdings for greater returns while maintaining a balance between risk and reward. The investor’s profile, which includes their financial objectives, the time horizon for investing, and level of risk tolerance, ultimately determines which fund they should invest in.
Additionally, developing an investment strategy aids in improving the performance of their portfolio. Furthermore, you may always speak with a financial counsellor if you have questions regarding your asset allocation strategy. As a result, they can assist you in making wise financial choices.
